» Business » Houses @ Rs 7 lakh: Dream or reality?

Houses @ Rs 7 lakh: Dream or reality?

By Shobhana Subramanian
July 03, 2009 10:05 IST
Get Rediff News in your Inbox:
It's wonderful that Jerry Rao is planning to build houses that cost Rs 700,000 or less. The former Citibanker's model is simple enough: land is bought with the equity capital while construction is financed through bank loans at market-related rates currently anywhere between 11 and 13 per cent.

The key to the success of the project is the time taken to complete it. If the houses are ready in 12-18 months as planned, Rao expects he can generate a return on equity (ROE) of close to 30 per cent. The ROE, of course, keeps falling as the time to completion increases and after 36 months, drops to single digits.

The big difference between this model and that followed by most developers today is that land is treated as inventory and not as an asset. Typically builders try to buy land cheap and hoard it till the price appreciates after which they extract a higher price from home buyers.

The short point is that most developers today are trying to make money from the land rather than the project. Since they believe land prices will appreciate, they are in no hurry to complete their projects - they divert money received from customers for one project to some other venture and there's no accountability, whatsoever, when it comes to completing projects on time.

Of course, they stand to profit enormously from the price appreciation -operating profit margins for leading developers have been upwards of 60 per cent before the downturn began. And if the debt blows up in their faces, there is always the government to bail them out! It's time developers were asked to house each project in an SPV, as will be the case with Rao's venture, so that the money can be kept track of.

For sure, there are a couple of risks to Rao's model. The first is that given the relatively low selling price, restricted to between Rs 1,300 and Rs 2,000 a sq ft, the projects necessarily need to be located not just on the outskirts of cities but perhaps way beyond that.

Boisar, where Tata Housing's project is coming up for instance, is located 100 km from Mumbai. The question is whether people will be able to commute from these distances, how much time they will spend travelling and how much it will cost them. If  people can't get to the place of their work within a reasonable amount of time, they would rather live in a chawl.

The response to Tata Housing's Boisar project , however, suggests there's huge pent-up demand at this price point. Whether people are planning to live in Boisar or only move there when they retire, remains to be seen.

The other question is whether the prospective buyers will be eligible for home loans. Buyers will somehow manage to put together the down payment and may well be in a position to pay back the loan.

But will banks be willing to take on the credit risk and bear the relatively higher cost of customer acquisition of these small-ticket loans? If they're not willing then the effective demand for this kind of housing could be far lower -just in tens of millions maybe, rather than in hundreds of millions.

The biggest risk though is execution because state governments, with their bureaucracy and red tape, can hurt developers badly. Real estate is known to be a dirty business but it will be really unfortunate if projects like Rao's are hurt by inefficient and corrupt officials.

That will keep other developers away given that these are already low-margin projects. Already bigger developers weren't even willing to construct apartments for middle-income groups till the downturn forced them to do a rethink.

Many now claim to be doing 'affordable' housing, though the prices don't suggest that; all they're doing is building smaller houses and selling them at slightly lower than the peak rates.

In a recent report, CRISIL has defined affordable to mean a price that 60 per cent of the population in a particular area can pay. It's found that in the top six cities, this price is below Rs18 lakh, in tier II cities like Pune and Ahmedabad, it's below Rs 16 lakh, while in places like Ujjain or Aurangabad, it's below Rs 9 lakh.

It's clear from this that most people can't dream of owning homes within city limits given land prices. Since the government is doing precious little to help out, it should at least ensure that projects like Rao's take off.

Get Rediff News in your Inbox:
Shobhana Subramanian
Source: source

Moneywiz Live!